The ETF 500 is a Who’s Who Register for ETF aficionados.
The requirements for inclusion are simple – how much investor money have they attracted. Follow the money, as they say.
A brief summary of the facts
According to research firm ETFGI, there are 5,024 ETFs trading globally.
There are 1,756 ETFs based in the U.S.
If you include ETNs (exchange-traded notes) there is an additional 1,888 globally and another 268 in the U.S.
There is $5 trillion dollars sitting in ETF products. (That is a metric s**t-ton of money.) It should be self-evident that the ETF universe is a major factor in modern capital markets. The question on the minds of thought leaders is, what will happen when the next bear market comes along?
And just to fill out the rest of the global capital market picture, there is:
- $32 trillion dollars in u.s. equities;
- $82 trillion dollars in the global equity market;
- $115 trillion in the global bond market.
O.K. Enough with the stats already. Let’s move on.
Is there a danger of the ETF market becoming too big?
There has been a flurry of articles recently, in the blogosphere and in respected financial and academic journals, that have raised this question. So far, nobody seems to have a definitive answer. So I decided to weigh in with my own views on the matter.
The definitive answer to this question is a resounding yes. But we are far away from the tipping point. I set about the task of slicing and dicing the ETF universe in an effort to figure out what exactly is going on, and whether we investors should be concerned about the rapid growth in this investment vehicle.
The first thing I did was find a reliable dataset that included as many ETFs as possible. I started with AAII, then ETFDB, and ETF.com. After eliminating duplicates I ended up with a list of 7,180 Exchange Traded Products.
My Initial Observations
It’s not the amount of money that’s socked away in these products that bothers me, it’s the number of flavors on offer. 7,000 is simply too many, in my opinion.
I decided to rank all 7,000 names by assets under management. I then imposed an arbitrary limit of $500 million U.S. dollars to make the cut. Hey, you’ve gotta start somewhere.
What I ended up with is the ETF 500. (Actually there are 479 names that made the cut, but there are also fewer than 500 names in the S&P 500.)
My intention all along has been to reduce the overwhelming number of choices available to investors, and get to a more reasonable and manageable stable of candidates for investing.
The Categories that are viable for investors
When I looked at the surviving names, and organized them into categories (asset classes, strategies, sectors, etc.) I ended up with 38 viable options for investors. When I say viable, I mean that there is enough trading volume and sponsorship to support each category, and there is sufficient investor interest to make them legitimate.
I won’t list all 38 categories, but I will give some of the highlights. If you want to see my spreadsheet, which contains all of the raw data on the ETF 500, I will provide a link at the end of this article.
- Large Cap Stocks. No surprise there. Big institutions dominate the market and they want lots of liquidity.
- General Bonds. Again, no surprise. Same thinking as above.
- Preferred Stock. This was a surprise to me. The preferred stock space is kind of mysterious for most investors. I get that the attraction is a higher yield and a better position in the bankruptcy queue, but still. I guess the big boys are fond of preferreds.
- Inflation protected bonds. Another surprise for me. TIPS pay little to nothing, so why would a big pension fund or college endowment be attracted to them? I guess it’s the allure of a hedge against inflation. Seems dumb to me.
- Real Estate Sector. Another surprise. Given the recent history of global real estate, I can’t for the life of me understand why the big guys are putting so much money into this sector. Are we headed for another real estate bubble? I don’t know, but this little factoid might be a clue.
Final thoughts
I mentioned earlier that respected thought leaders in the investment business are expressing concerns about what could happen when the next bear market arrives. There are two camps on this issue. The optimists point to the 1970s, when mutual funds were relatively new and had attracted a similarly large share of investors’ dollars. They say that, if the market survived that, then it will survive the ETF boom too.
The pessimists argue that at some point, and we don’t know when, the amount of money in ETF products will present a real risk to the market. When a large institution decides to liquidate a huge position in one of these ETFs, nobody knows for sure what will happen. What we know is that the ETF provider will have to sell shares of stock on the open market to meet redemptions.
We could conceivably see a scenario where there are no buyers to take the other side of massive sell orders. We saw this in 1987, and that was a near-disaster. The market dropped 25% in a single day. That’s still by far the biggest one-day decline in market history. Not even the crash of 1929 can match it.
I don’t want to imply that doomsday is looming ahead. But this $5 trillion dollars is a force to be reckoned with. That’s why I am suggesting that ETF investors might want to stick with the largest and most liquid funds.
Book recommendation
There is a great book by Barry Schwartz called The Paradox of Choice that was part of my inspiration for this article. It’s on Amazon, naturally, and you might want to check it out. (I have no revenue deals with Amazon.)
If you’re not into the whole read-a-book thing, you can also watch his Ted Talk to get the general ideas that he discusses in his book.
The point of this article is that, if you are going to include ETFs in your portfolio, I suggest that you stick with the Aristocrats and avoid the Wanna-be’s. That’s the purpose of the ETF 500.
Here is the link to my full spreadsheet.